Definition: The accounting cycle is a collection of processes and activities that are performed to effectively keep track of a company’s financial information, including but not limited to financial statements, reports, forecasts, executive opinions, etc. An accounting cycle collects all of the relevant financial information related to a company or financial period, including revenue, expense, income, and taxes.
An accounting cycle helps both the company’s management and its investors by ensuring that all financial transactions are accounted for correctly. When a transaction occurs, whether it is a purchase or a sale, the cash remains in the seller’s accounts of the good or service until the money is spent on something else or the negative balance is satisfied. Therefore, every business that sells goods or services must have accurate records so that improper payments won’t slip through the cracks, or an item could be sold at a higher price than it should be because of a printing error. To avoid this from happening, companies must regularly commit to account reconciliations and cash management activities.
8 Steps in an Accounting Cycle
There are multiple steps in a typical accounting cycle.
1. Identify Transactions
The essential step is to gather financial information about the company. This can include income statements, balance sheets, revenue and expense accounts, taxes, cash flow statements, and others.
2. Record Transactions
The purpose of this step is to ensure that your accounting records are accurate and match your report on your tax return. Recording your transactions in a journal is one method you can use to track what transactions occur each quarter or year. Journal entries can also help you remember the details of a transaction if certain information is lost along with it, such as invoice numbers or instructions. If you lose your logbook or get damaged, it’s easy to replace or gather replacement materials for audit purposes.
An entry is made in the general ledger if all necessary information for that transaction is entered into the transaction log. The general ledger covers a period of time or transaction volume. For example, the general ledger may include entries for receivable and inventory, but not necessarily any payments which occurred after these are entered into the ledger.
4. Create an Adjusted Trial Balance
The Adjusted Trial Balance is what we might liken to the rolling balance that is a balance recorded as a liability for accounting purposes. This balance, and the other types in this cycle, ensure that debits equal credits on a balance sheet and total debits no longer exceed total credits on the same statement. This balance can be held via an unadjusted trial balance or an adjusted trial balance.
For Accounting Cycle, users are required to input various data into a worksheet or data entry form, including invoices, schedules, and records. Each field must be entered accurately, and the data entered must match the other required information in the data entry form. Once all of the necessary information is entered, if any discrepancy is found between the inputted information and what is shown on the screen, adjustments will need to be made.
6. Adjusting Journal Entries
Adjusting entries in a journal is done regularly. At the end of each period, all entries should be correct. To make entries accurate, you need to think about the previous period and correct any mistakes or incorrect data that may have accumulated.
7. Financial Statements
Once all the entries are done and adjusted, the company prepares the actual formalized financial statements such as the balance sheet, income statement, and cash flow statement.
8. Closing the books
In this step, the books are closed, providing an accurate account of your financial activity. This usually happens about a month after the end of the previous period. At the end of the period, revenue and expense accounts are created with zero balances from any sales or purchases in the period. These are used for the next accounting period.
The Accounting Cycle involves completing a series of tasks associated with accounting. During this time, we prepare our financial statements, reports, and internal documents. Once the cycle is complete, there is no balance in any account. All activity takes place in accordance with accounting rules and regulations. We have processes in place to ensure correct reporting and compliance.